4 nd Chapman Conference on Money and Finance LIQUIDITY: PRICING, MANAGEMENT AND FINANCIAL STABILITY September 6-7, 2019 CDS Central Counterparty Clearing Liquidation: Road to Recovery or Invitation to Predation?” Magdalena Tywoniuk University of Geneva Wolfgang Bessler Justus Liebig University Giessen | Center for Finance and Banking Goethe University Frankfurt | Center for Financial Studies
Outline I. Financial Crises, Systemic Risk, and Central Counterparty II. Research Issues, Questions and Evidence III. Risk Management of Clearing Houses IV. Recovery and Resolution of CCPs V. Summary and Conclusions Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 1 -
Systemic Risk of Central Counterparties (Clearing Houses, CCPs) • Interestingly, there is no generally accepted definition of systemic risk and how to measure it. “ hard-to-define-but-you-know-it-when-you-see-it” • All definitions attempt to capture risks to the stability of the financial system as a whole as opposed to the risk facing individual financial institutions or market participants (FSOC, 2011). • The focus of most research and regulatory approaches is essentially on banks. It is often assumed that it can be easily transferred from banks to other institutions and markets such as clearing houses (CCP) and mutual funds. • This perspective totally neglects the differences in the intermediation process between banks and securities markets and clearing houses . Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 2 -
The financial crisis highlighted risks in the OTC derivatives market – in particular, those linked to non-central clearing Root causes of Description systemic risk • Wrong incentives, including moral hazard IMF and European Excessive risk • Deficiencies in controlling and pricing risk taking Commission • Domino effect due to failure of single estimates put counterparty I nterconnected- • OTC derivatives joins together a broad direct bail-outs of ness range of firms within opaque structure banks at 4.6% of Insufficient EU GDP, indirect • Low or no collateralisation, reflecting collateral TBTF or business driven risk support at 13%, in case of management default crisis related costs • Individual firms assumed counterparties at 8%, and GDP could be replaced –but not organised structure in place to create a real market Insufficient contraction of 6%. equity in case of • Losses are higher than CCP equity default Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 3 -
Clearing Member Defaults Defaulting Clearing Member Year Clearinghouse Default Loss Loss Volume Investors Corporation 1985 Comex Clearing Ass. $9 million Yes H. B. Shane 1987 Options Clearing Corp. $8.6 million Yes Multiple firms 1987 Futures Guarantee Corp. Exact figure unavailable Yes New Zealand Futures and Jordan Sandman Futures Ltd. 1989 GBP 1 million Yes Options Exchange Drexel Burnham Lambert Ltd. 1990 LCH.Clearnet Exact figure unavailable No Woodhouse, Drake and GBP 900,000 (before 1991 LCH.Clearnet No Carey (Commodities), Ltd. defaulter’s resources) Lee B. Stern & Co. 1992 Board of Trade Clearing Exact figure unavailable; Yes Barings Futures (Singapore) Ltd. 1995 SIMEX Exact figure unavailable; No Barings Securities (Japan) Ltd. 1995 Osaka Securities Exchange Exact figure unavailable Unavailable Klein and Co. Futures, Inc. 2000 New York Clearing Corp Exact figure unavailable; Yes Lehman Brothers 2008 LCH.Clearnet /EUREX Exact figure unavailable No MF Global UK Limited 2011 LCH.Clearnet Exact figure unavailable No Cyprus Popular Bank Co. Ltd. 2013 LCH.Clearnet Exact figure unavailable No HanMag Securities 2013 Korea Exchange (KRX) CCP KRW 46 billion Yes Maple Bank GmbH 2016 LCH.Clearnet Exact figure unavailable No Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 4 -
European Commission: Safer Financial Infrastructure Given their growing importance in financial markets, the failure of a central counterparty could affect banks and the wider economy. The Commission therefore proposes rules to require CCPs and national authorities to prepare for and deal with financial difficulties. Share of global OTC derivatives The EU clearing market cleared through a CCP obligation for OTC derivatives has led to a large increase in clearing through CCPs CCP clearing is likely to increase substantially in the coming years. Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 5 -
Market Concentration among European CCPs in Central Clearing 1) Turnover of centrally cleared financial products in 2015 (nominal values). 2) Measured by the Herfindahl-Hirschman Index (HHI). Market concentration is considered heightened as of an HHI greater than 1,800. ECB and Bundesbank calculations Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 6 -
European Commission: Safer Financial Infrastructure Central Counterparties (‘CCPs’) increase stability in financial markets. They are critical in helping to reduce risks in the wider economy. They help financial firms and corporates manage their risks. The Commission wants to make them even more robust. Central counterparties play a key role in international financial markets. They process big and increasing volumes of derivatives trades every day. Almost More than 17 EUR 500 15 times EU GDP trillion Value of all ‘over- Number of The global volume of the-counter’ (OTC) CCPs in EU derivatives currently derivatives currently cleared by CCPs held globally Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 7 -
Cleared US Dollar Credit Default Swaps Ice Credit Clear dominates with 98% share. CME shutting down its service. LCH CDS with $3 billion in Q1 2019. Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 8 -
Cleared Euro Credit Default Swaps Ice Credit Clear 56.8% Ice Clear Europe 32.6% LCH CDS Clear 10.6% Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 9 -
More Banks are joining the CCPs as Clearing Member for their Clients April 8, 2019 Deutsche Bank introduces client clearing through LCH CDS Clear . Deutsche Bank is the first German bank to offer client clearing in US and European CDS . Asset management firms MEAG and Union Investment are the first buy-side clients to connect to CDS Clear via Deutsche Bank. July 3, 2018 LCH CDS Clear adds JP Morgan as first US bank to CDS clearing service JP Morgan is using LCH CDS Clear to act as a clearing broker in CDS for Swedish pension fund AMF. April 29, 2019 LCH CDS Clear adds Banca IM I as first Italian clearing member Banca IMI has signed up as a clearing member for CDS , making it the first Italian clearing member to join the service. It will also act as a clearing broker for clearing CDS for its client base . “ Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 10 -
Partnership Program Participants at Eurex Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 11 -
Product Structure of Eurex Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 12 -
Outline I. Financial Crises, Systemic Risk, and Central Counterparty II. Research Issues, Questions and Evidence III. Risk Management of Clearing Houses IV. Recovery and Resolution of CCPs V. Summary and Conclusions Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 13 -
Research Ideas, Questions and Evidence • Regulation and the clearing CDS by CCP, make CCPs systemically important • Paper analyzes potential failure of a CCP due to default of a large dealer bank . • Market Impact of the unwinding of its positions . • Price impact of liquidation and predatory selling by dealer banks . • It provides a measure of covariance between assets in banks’ portfolios. • Key results show that liquidation lowers CCP profits , • Predation decreases the profits of all members, pushing banks to default . • A hybrid CCP structure provides a natural disciplinary mechanism for predation. • It more incentive compatible for the CCP , in expectation of a large loss. • Model provides regulatory implications for a Lender of Last Resort in various liquidity scenarios. Wolfgang Bessler Center for Finance and Banking Justus Liebig University Giessen and CFS Goethe University Frankfurt | - 14 -
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